Market Making & Trading

How quotes, spreads, information and inventory interact, and how to size and evaluate bets.

Lessons · recommended order

  1. 1Bid, Ask and the SpreadThe bid-ask spread is compensation for providing liquidity and bearing risk, not free profit.
    Foundations
    7 min
  2. 2Expected P&L of a QuoteComputing a market maker's expected profit means weighting spread capture against the probability and cost of adverse fills.
    Intermediate
    8 min
  3. 3Market Making: Earning the SpreadA market maker's edge comes from high-frequency spread capture on uninformed flow, offset against losses to informed traders.
    Intermediate
    8 min
  4. 4Adverse SelectionAdverse selection is the loss a market maker expects because the counterparties most eager to trade are often the best informed.
    Intermediate
    9 min
  5. 5Inventory Risk and Quote SkewingA market maker with unwanted inventory skews quotes to encourage trades that reduce risk, even at a worse expected price.
    Intermediate
    8 min
  6. 6The Kelly CriterionKelly sizing maximizes the long-run growth rate of wealth by betting a fraction proportional to your edge.
    Intermediate
    8 min
  7. 7The Sharpe RatioSharpe ratio measures risk-adjusted return; annualizing it by $\sqrt{\text{periods}}$ relies on an i.i.d. returns assumption.
    Foundations
    7 min
  8. 8Simple vs. Log ReturnsLog returns are additive over time and better suited to compounding math; simple returns are the raw period-over-period percentage change.
    Foundations
    6 min